R&D ready for a tax break

Gordon Brown looks set to introduce tax credits to prevent an exodus of R&D operations from the UK.

UK research and development spending levels are way below those in the US and many other competing economies. But R&D tax credits could change all that, and many are betting that the next Budget, due in March, will finally deliver something of real value to UK industry.

Early signs that the Chancellor was becoming more open to the idea came with the pre-Budget statement last autumn, when Gordon Brown said the government would assess the case for extending existing tax credits for small businesses across all companies. He has mentioned the proposals again on numerous occasions.

And last month, he even said he would be lobbying EU finance ministers to relax some of the rules on state aid to make sure such a move did not fall foul of Brussels. There is a good case to be made for tax credits at a European level, as it is not just the UK which is lagging. EU spending on R&D averages 1.8% of GDP, compared with 3% in Japan and 2.8% in the US.

UK lags behind

The lead the US has built up over Britain is most often cited as evidence of how far behind we are. Taking other measures (from the DTI’s official R&D Scoreboard 2000), R&D intensity, which measures R&D as a share of sales, is 2.1% in the UK — less than half the US figure.

And companies investing at a high intensity in the US represent around a quarter of the total companies surveyed, whereas in the UK, the figure is about 4%.

This tiny percentage is made up of some fairly big players, but concentrated in just two sectors: aerospace and pharmaceuticals. The concern of many industry leaders — and increasingly, of the government — is how the rest of the industrial sectors can make some kind of improvement.

This is all in line with the government’s ambitions to foster a ‘knowledge-based economy’ for the UK, where high value-added activities take the lead, giving the country a level of immunity to cheaper global competitors.

However, with multinationals increasingly taking on ownership of UK industry, the choice of where to carry out R&D is becoming more and more open-ended. The threat of R&D operations being shipped abroad is becoming increasingly relevant, so the kind of government support provided to back R&D in rival countries is becoming a hot issue.

In the UK, tax credits only apply to companies with a turnover of less than £25m — yet most R&D is carried out by large firms. By contrast, large firms operating in countries such as Australia, France, Japan, Korea, Mexico, and the US and Canada receive tax credits for research activities.

Economists who have studied the effects of tax credits in great detail, making allowances for all the other costs involved, conclude that they do work. The OECD agrees. And historical data seems to back it up.

Probably the best example of tax credits in action can be found in the US, where a tax credit

was introduced in 1981 and has been running, with a number of changes, ever since. The National Association of Manufacturers (which represents a broad swathe of US industrial companies) last year put together research which concluded that the tax credit did boost investment in R&D, simply by lowering the costs to the firm.

How tax credits work

The credit works, the association said, because in the manufacturing sector, technological advances are responsible for up to two-thirds of economic growth in the sector. Gains from the credit continue to affect the growth rate year after year.

When the EEF publishes its Budget submission to the Treasury next week, it will tell the Chancellor that a 50% tax credit for large companies could pay for itself — because much of the cash paid out to the companies would be recycled back to the Treasury in the form of tax and National Insurance contributions from the extra research staff taken on.The sums seem to add up and all in all the Chancellor appears to have little to lose on the issue. But if he fails to deliver, a large number of very senior UK industrialists could have good cause to complain.

The EEF’s Budget submission is published next Monday, and contains more detailed analysis of the tax credit system.